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Wednesday, May 20, 2009


Today's Buggy Topic

It's found in a thread at Brad Setser's web-site, run by the Council of Foreign Relations, that operates under the name of "Follow the Money" . . . Setser himself a former USA Treasury official, who specializes in financial relations between the USA and others --- including, among other key topics, the contentious exchange-rate mechanism that China runs with the $US.  Setser probably knows more about this politically charged financial and trade mechanism and the overall Chinese-American economic relationship than any other specialist in the world.  Prof bug, interested in this relationship for its own sake --- but even more for the diplomatic, economic, and military implications of China's rapid rise in economic prowess for the overall American global role --- reads most of Setser's daily columns with ongoing regularity and appreciation.

Doubly so, please note, because China's huge investments of its 1.5 trillion US dollars --- an outcome of its large annual bilateral trade surplus with the US for well over a decade now --- in US Treasury bills and bonds, as well as in other US financial assets, is partly hidden and hard to trace.  All in all, Setser traces it more effectively than anyone else in public writings . . . or so it seems.

Click here for the Setser post that started the thread, then run a buggy search --- or for Michael Gordon --- and then note a reply two or three posts later from Dr. Setser to the bugged-out comments.   (Observe that Dr. Setser corrected a buggy error.  Prof bug thought that Thailand's reserves of foreign currency were virtually all US dollars; Dr. Setser noted that it also holds a lot of euros.  That means the Thais could, in principle, swap euros for Chinese Renminbi (Yuan) and use it as a reserve currency, without Beijing having to take on more dollars for its reserves than it might want to hold.)

Note: Before You Click on the Setser Link, Do Two Things First

  1. Read the rest of the buggy commentary here.  It will provide you with a broader perspective on the question of China's future role in the global financial system.  
  2. And, for an even rounder perspective on the challenges and problems that the Chinese Communist Party leadership faces in guiding China's overall economic development --- in particular, in achieving the CP's aspirations that China become a rich, technologically advanced country and hence an eventual great power --- you might find it worth while to read this lengthy buggy commentary that prof bug set out a few weeks ago at Economist's View.  Click here for that bugged out stuff

And now back to today's buggy comments.

The Overall Economic Relationship Between China and the US Clarified

Start with China's epochal developmental transformation since 1979, the start of the post-Maoist shift of the Chinese Communist Party leadership to move toward a state-directed market-economy not that much different, three decades later, than the kind of statist economy that, say, South Korea operated under in the era of its military dictatorship between the 1960s and the later 1990s. 

The result is an economy that is increasingly market-oriented, but still under the CP's direction in key areas: dominance by the government of major banks, controls over investment flows in and out of the country, restrictions on imports, subsidies to exports ---- the major subsidy a managed exchange rate that keeps the Chinese Yuan (called the Renminbi for external use with foreign countries) under-valued in dollar-terms ----and a large sector of state-owned giant firms that the CP has trimmed mightily in employment the last two decades, but still important enough to influence the overall economy's functioning.  Among other things, that means these state-owned enterprises have more investment capital allocated to them by the government-controlled banks than would otherwise be the case in a free-market.

The major difference between the current Chinese economy and the South Korean economy in the military dictator era is that China has been markedly more open to multinational investment from abroad: mainly from Taiwan, South Korea, Japan, Singapore, the USA, and the EU.  The result has been an increasingly fast climb up a ladder of manufacturing skills, output, and productivity.  In effect, about 60-65% of China's manufacturing exports yearly to the rest of the rest are pass-through of foreign multinational technology and component-parts, with these multinational firms using disciplined, fairly skillful Chinese labor as a low-wage assembly plant on a vast scale for exports. 

The Outcome?

It's three-fold:

  • Outcome One: China's economy has become heavily dependent on export-led growth as the major stimulus to overall domestic production.  Its trade with the outside world between 1998 and the start of 20o8 expanded by 500%.  Between 2003 and the end of 2007, as the global economy's growth mushroomed, its exports were growing at an astounding 17% or so a year.  In 2007, its $1.3 trillion of exports were about 37% of China's total GDP.  Together with domestic investment, the result is that domestic consumption in China is AN astonishingly low 39% of GDP (again at the end of 2007, before the global economy's recent meltdown).  There's never been an economy in Asia or elsewhere where domestic consumption has had such a low share of GDP.

Some clarification seems in order here:

  1. China's main export partners are the US 19.1% of the total, Hong Kong 15.1%, Japan 8.4%, South Korea 4.6%, and Germany 4% (2007)   And its main import partners are Japan 14%, South Korea 10.9%, Taiwan 10.5%, US 7.3%, Germany 4.7% (2007)
  2. Note in passing that Germany was the world's largest merchandise exporter in 2008, its sales abroad totaling about $1.5 trillion (about 49% of Germany';s GDP!).  That gave it 9.1% of total goods exports in the world economy.  China came in second with $1.4 trillion worth of exports and placed it second at 8.9% of global export-trade in goods.  The US was third: its exports of goods totaled $1.3 trillion or 8.1% of global export-trade.  Japan was fourth, with 4.9% of the total, and Holland was 2nd with 3.9%.
  3. If you add in goods-imports to trade, the US bill was $2.17 trillion or 13.2% of total imports world-wide.  Germany came in second, with $1.21 trillion worth of imported goods or 7.3%.  China came in third ($1.13 trillion or 6.9% of total global imports); Japan fourth ($762 billion or $4.6%) and France fifth ($708 billion or 4.3% of the total).   
  4. Add in commercial services --- financial services, transports of goods, tourism, movies, TV, and so on ---the US remains by far the biggest overall trader (with a big surplus in such services) among countries world-wide, but with the EU as a whole (again excluding internal trade) holding a slightly higher percentage.  Remember here: the US population is about 300 million, and the EU's about 500 million.  The overall US GDP in Purchasing Power Parity is about the same as the EU's --- roughly $14.5 trillion last year.  In per capita income calculated in PPP terms (not existing exchange rates) ---- PPP measures seek, recall, to overcome fluctuations in exchange rates by trying to equalize price-levels in different economies ---- the US's was $47,000 and the EU's about $33,400.  Germany's, France's, and Britain's per capita income are slightly higher than the EU average.

What emerges?  In effect, the US remains one of the two biggest traders in the world, with about 26% of the total; and its import-buying consumers are much richer than those elsewhere . . . two data-points that are relevant to its maintenance of the $US as the primary reserve currency globally: about 64% of the total.  The EU as a whole --- excluding its internal trade --- is a close rival of total world trade, and with the Euro accounting for about 26% of the reserves held by foreign Central Banks.  The remaining reserves are small amounts of Yen, Swiss Francs, and British pounds, plus some SDR's (special drawing rights furnished by the IMF, based on a basket of currencies). 

  • Outcome Two/ No less important to China's epochal economic transformation has been the technological transfers from abroad, thanks to multinational operations in the country, and its (limited) diffusion across the overall economy.  True, the Chinese CP leadership knows that its firms --- those operating on their own or in joint ownership with foreign multinationals --- are still not anywhere near the technological prowess of Japan or South Korea, never mind the USA.  It keeps hoping for a leap-forward in such prowess, with big proclamations.   So far, that's about all that has happened.  Over time, though, it's likely that Chinese manufacturing will improve on the technological scale as well --- even if it is still unlikely to catch-up with the technological frontier where the USA is at the head, with Japan, South Korea, the smaller EU Scandinavian countries somewhat behind, along with Germany, France, and Britain.

--- In effect, as Chinese manufacturing wages increase, Chinese firms --- or jointly run firms with multinationals (who transfer only a little of their advanced technologies to their Chinese production) --- will have little choice but to try upgrading their own technological creativity.   Trying, of course, isn't the same as succeeding.  And simultaneously, the closer a country approaches the technological frontier, the more it has to spend on its own R&D rather than rely on imported technologies either by licensing agreements or by multinational implants and transfers. 


--- The problem here is complicated for the Chinese because right now there is little effective protection of patents --- foreign or domestic.  Since technological breakthroughs --- or even a fair amount of R&D adapting imported technologies to local Chinese conditions --- are expensive, with invariably a large amount of expenditures wasted by trial-and-error --- property rights over patents and for that matter of all sorts need to be notably strengthened in the country.  Otherwise, why would any Chinese innovative firm spend so much money on big breakthroughs or even imported technological processing unless it could be sure by means of patents that it could recoup its expenses and make a profit?  And that leads to all sorts of problems that now encumber the Chinese legal system.

  • Outcome Three: China's bilateral trade-deficit for the US with China climbed to around $256 in 2007 . . . since which time, interestingly, as the US economy moved into recession and American households moved from a negative savings rate to around 4.4% of their after-tax income, overall US imports started falling fairly fast, but not Chinese imports.  At the end of 2008, the bilateral trade deficit with China actually rose to $266 (though it was slowing down in late fall). 

The Key Chinese-American Relationship That Follows From All This

Well, come to think of it, no need to say more here.  The earlier link to this buggy analysis posted a few weeks ago at Economist's View will fill in with the necessary background.